Is Silicon Valley in Another Bubble . . . and What Could Burst It?

CITY BY THE FROTH
In the U.S. alone, nearly 100 tech start-ups are currently considered unicorns.

Photo Illustration by Sean McCabe.

One Thursday morning in early June, the ballroom of the Rosewood Sand Hill hotel, in Menlo Park, was closed for a private presentation. The grand banquet hall appeared worthy of the sprawling resort’s five-star designation: ornate chandeliers hung from the ceiling; silk panels with a silver stenciled design covered the walls. Behind a stage in the 2,800-square-foot room, a large sign bore the name of Andreessen Horowitz, one of Silicon Valley’s most revered venture-capital firms.

As breakfast and coffee were offered, the company’s partners mingled with the men and women who endow their $1.5 billion fund. The investors were dressed invariably in business casual, with the top button of their dress shirts noticeably undone. (A mere handful of men stood out in a suit and tie.) Off in the distance, you could make out the faint purr of Bentleys and Teslas ferrying along Sand Hill Road, depositing the Valley’s other top V.C.’s at their respective offices—Greylock Partners, Draper Fisher Jurvetson, and Sequoia Capital, to name just a few—for another day of meetings with founders, reviewing the decks of new start-ups, and searching for the next can’t-miss company.

After some chitchat (Mitt Romney had addressed the group the previous night), Scott Kupor, a managing partner, took the stage to tell the assembled investors what was going on with their money. A16z, as the firm is commonly known in the Valley, had invested hundreds of millions of dollars in some of the industry’s biggest companies—Instagram, Facebook, Box, Twitter, and Oculus VR—along with a number of upstarts, such as Instacart, a grocery-delivery business that had been recently valued at about $2 billion. After the guests found their seats, Kupor began moving through a series of slides depicting the past and present of the tech sector, using data that would help inform the firm’s investments in the future. Each set of numbers had been meticulously researched and culled from sources that included Capital IQ, Bloomberg, and the National Venture Capital Association.

Yet the presentation, which adhered to a16z’s gray-and-deep-orange palette, seemed to have an ulterior motive. Kupor, his hair neatly parted, was eager to assuage any worry about the existence of a tech bubble. While he conceded that there were some eerie similarities with the infamous dot-com bubble of 1999—such as the preponderance of so-called unicorns, or tech start-ups valued at $1 billion and upward—Kupor confidently buoyed his audience with slides that read, “It’s different this time,” and charts highlighting the decrease in tech I.P.O.’s, the metric that eventually pierced the froth in March of 2000. Back then, a company went public almost every single day; now it was down to about once per week. This time around, he noted, the money was flowing backward. Rather than entering a company’s coffers in the public markets, it was making its way to start-ups in late-stage investments. There was little, he suggested, to worry about.

And then, toward the end of his reassuring soliloquy, the ANDREESSEN HOROWITZ sign fell from the wall and landed on the floor with an ominous thud. As the investors looked on, some partners in the Rosewood ballroom laughed awkwardly. Others did not seem so amused.

While the rest of the country has spent the past year debating gay marriage, policing tactics, Obamacare, and Deflate-gate, the inescapable topic of discussion in Silicon Valley is whether we are in a technology bubble. Marc Andreessen, the co-founder of his eponymous venture firm, is perhaps the leading advocate against the bubble chatter. On his Twitter feed, he has referenced the word “bubble” more than 300 times, repeatedly mocking or refuting anyone on his radar who even hints at such a possibility. One of his arguments, as the slides in the Rosewood ballroom suggested, is the exponential growth of mobile phones, which have fundamentally changed the way we buy and sell virtually everything, from groceries to taxi-like services, and created unprecedented disruption. Also, in contrast to the days of the dot-com boom, many tech companies are creating revenue—in some instances, lots of it.

Andreessen’s points are all valid, but the bubble chatter is still impossible to quell, in part, because the signs are increasingly ubiquitous. When I moved to the Bay Area to cover the tech industry for The New York Times, in the summer of 2011, the Valley was still reeling from the bursting of the last bubble, which led to more than $6 trillion in losses, and sent the NASDAQ on a downward spiral similar to the Dow’s amid the Wall Street crash of 1929. In 2000, some start-up C.E.O.’s lost millions of dollars in a matter of hours. Others saw their entire net worth fall to zero in months. People vanished; commuting times were sawed in half; private investment ossified. At the time I arrived, LinkedIn was the only publicly traded social-media company. A little-known upstart with a catchy name, Uber, had just raised a seemingly staggering amount ($11 million) in venture capital. Postmates, Tinder, Instacart, Lyft, and Slack didn’t exist. Silicon Valley was an actual place, not an HBO show.

But within months I noticed that private money was returning and a cavalcade of start-ups were reshaping the city in their image. Engineers from companies I hadn’t yet heard of began showing up at open houses with checks written out to cover rent for the first few months (a recruiting perk, I later learned). I attended a jungle-themed Halloween extravaganza featuring acrobats, a 600-pound tiger, and other wild animals in order to bolster photo moments that people were posting on a hot new start-up, Instagram. Meanwhile, I was pitched countless apps to find a parking space, or messaging services to tell someone that you are running late. The founders told me their companies were worth tens of millions of dollars. When I asked for their logic, they looked at me as though I were the crazy one. Shortly after the Facebook I.P.O., I learned about a secret group within the social-network company called “T.N.R. 250”; it was an abbreviation of “The Nouveau Riche 250,” comprising Facebook’s first 250 employees, many of whom had become multi-millionaires. The members of T.N.R. 250 privately discussed things they wanted to buy with their windfall, including boats, planes, Banksy portraits, and even tropical islands.

Whenever I even suggested the word “bubble” in my reporting, I became a punching bag. After I scrutinized the ethics (and preposterous valuation) of Path, an ill-fated social network, Michael Arrington, once a nexus of power in Silicon Valley who had invested in the start-up, called me a “pit bull” and said I wasn’t a very noble person. But lately the worries have spread. There are now fast approaching 100 unicorns based in the U.S. alone, and counting. The NASDAQ recently closed at an all-time high, surpassing a record set right before the dot-com crash in 2000. The Shiller P/E ratio, a measure of the ratio of price to earnings, has a number of investors worrying, with The Wall Street Journal noting that it shows stocks are “frothy.”

Lately, in fact, even some of the most aggressive V.C.’s have cowered. Not long after the Andreessen Horowitz presentation, Roger McNamee, co-founder of the private-equity firm Elevation Partners, told CNBC, “We are going to have a correction one of these days.” Bill Gurley, a partner at Benchmark Capital and Andreessen’s nemesis (“my Newman,” as he recently put it, referring to the Seinfeld character), echoed this sentiment on Twitter, venture capitalists’ preferred platform of communication. (Many are staked in it.) “Arguing we aren’t in a bubble because it’s not as bad as 1999,” Gurley tweeted, “is like saying that Kim Jong-un is fine because he’s not as bad as Hitler.” (Gurley declined to comment for this story.)

But the best way to understand the current situation in Silicon Valley is to recall the last bubble. Mark Cuban, who sold his Broadcast.com for $5.7 billion several months before the dot-com bubble burst, told me that there is no question whatsoever that we are in the midst of another one. And as with the last one, there is no question that a lot of people will be devastated when it pops. “The biggest of all losers will be anyone who has borrowed money to invest in private companies,” he told me. “You were stupid. You blew it. You lost. That simple.”

“This Is Hubris”

Perhaps the clearest way to observe the tech industry is through its architecture. When the I-280 deposits you into San Francisco, the view is like no other in America. To the left, waves of thick fog roll slowly off Twin Peaks. To the right, dozens of massive container ships sit like specks on the bay. If you drive farther into the city, toward gilded Nob Hill, the area that once belonged to the robber barons—the city’s original entrepreneurs—is now filled with upscale boutique hotels. But as you enter the city itself, every corner of the sky appears the same: spikes of lanky cranes protrude hundreds of feet into the air, their fishing lines plucking concrete and steel from street level, stacking these beams atop one another.

San Francisco, a city that zones about half of its land for residential use, is on track to increase its office space by 15 percent, with a majority of it presumably allocated for tech start-ups. Travel about 50 miles south to Cupertino and you will see the site of Apple’s new gargantuan glass headquarters, “the Spaceship,” designed by Sir Norman Foster, which will span 2.8 million square feet and house more than 12,000 employees. And then there’s the new, recently occupied Facebook building, designed by Frank Gehry, with its rooftop park and what it claims is the largest open floor plan in the world. Google is currently planning its own updated campus—this one designed by Bjarke Ingels and Thomas Heatherwick— that will include an army of small crane robots, known as “crabots,” which can move office walls, floors, and ceilings and transform the spaces in mere hours.

Yet there may be no greater monument to what’s going on in the Valley than the 1,070-foot edifice under construction at 415 Mission Street. The new, glassy Salesforce Tower is slated to soon become the tallest building in San Francisco, rising more than 200 feet above the Transamerica Pyramid. And that may be a big problem. Vikram Mansharamani, a Yale lecturer and author of the book Boombustology, has argued that virtually every great bubble bursting has been preceded by an attempt to build the tallest buildings. Forty Wall Street, the Chrysler Building, and the Empire State Building were under construction during the onset of the Great Depression. The Petronas Towers, in Kuala Lumpur, were completed in time to inaugurate the Asian economic crisis. The Taipei 101 tower, once the tallest building in the world, laid its foundation right at the height of the dot-com boom.

Some of these buildings, which were erected through money obtained partly from bubble-gotten gains, rode on the assumption that the markets would continue to rise and there would be enough tenants to fill their floors. This trend has historically been true in other industries, too. An inflated art market, according to Mansharamani, is another troubling indicator of overconfidence. (Last May, Christie’s, Sotheby’s, and Phillips broke records by selling a total of $2.7 billion of art in a week and a half.) There’s also a precocious indicator some economists refer to as the Prostitute Bubble, where the filles de joie flock to increasingly frothy markets. (While it’s difficult to substantiate this theory, several bars in the city are well known for this kind of deal-making.) “I think we are absolutely in a condition that you would qualify as bubbly by any stretch of the imagination,” Mansharamani told me. “This is hubris, chest-bumping behavior: Bigger. Better. Wider. Me.”

In more quotidian ways, the mania that presided over 1999 is also back. During 2013, high-tech workers up and down
the peninsula were reportedly paid nearly $196,000 a year, on average, and some made several million dollars in stock. Other programmers have their own agents, much like Hollywood stars. Some interns have been paid more than $7,000 a month, which adds up to about $84,000 a year. (The median household income in the United States is around $53,000.) Snapchat has offered Stanford undergrads as much as $500,000 a year to work for the company. Jana Rich, founder of Rich Talent Group, a well-regarded tech recruiting firm, told me that she hasn’t seen such bidding wars since the late 90s. “I’ve seen two of these life cycles, where things are going fabulously well,” she said. “Then we have the bust. We are now, in my opinion, at the height of the demand curve.”

Other tech recruiters noted that every little detail of the hiring process is again up for negotiation, just as it was in 1999, with an increased emphasis on extravagant stock-option packages that could ultimately yield several million dollars. This era also brings the allure of all manner of gourmet cafeterias, exercise rooms, open terraces, and unorthodox cubicles. Sometimes the demands are prosaic: one recruiter told me that an engineer requested closer proximity to the free-snack station. Other times, less so: a Google executive was reportedly paid $100 million not to leave the company for a competitor. Google, or its new parent company, Alphabet, seems to have enough money to throw some of it away.

This euphoria has created a debauched culture that also hearkens back to the last bubble. In 1999, thousands of instantly rich young people would line the city streets and cram into bars and event halls to gorge themselves on the endless flow of multicolored booze and hors d’oeuvres. Every night, it seemed, a blowout was being thrown by companies like Kozmo—a precursor to Postmates or any of the current errand-running sites—that later lost more than $250 million. Some parties had acrobats and fire-breathers. Others gave away gadgets and clothing.

Now a recent “Product Hunt” Happy Hour, where entrepreneurs network with investors, attracted more than 4,000 people, according to the Facebook invite page. At another event, hosts handed out free Apple TV set-top boxes as thank-you gifts. A prominent Facebook employee’s birthday party was orchestrated like an elaborate wedding, with ice sculptures, chocolatiers, and half a dozen women who walked around with card tables hanging off their waists so that guests could play blackjack while staring at their chests. A Google executive’s “40th-and-a-half” birthday party had elaborate acrobatics. In recent years, Burning Man, the annual art-and-music festival in the Nevada desert, has started to swell with venture capitalists and employees from Google, Twitter, Uber, Facebook, Dropbox, and Airbnb. (In 2012, Mark Zuckerberg flew in for a day on a helicopter.) These newly minted rich have eschewed the paltry sleeping conditions for private camps on what has become known as “Billionaires’ Row,” where some spend the night in custom-built yurts with their own power generators and air-conditioning. The most luxurious camps can come with teams of “Sherpas,” waiting on tech elite at a three-to-one ratio.

On any given night a dozen venture firms will host V.I.P. dinners at the city’s five-star restaurants, or on its own Billionaires’ Row, for designers, chief technology officers, or young entrepreneurs to meet and mingle. Some of these dinners even have the promise that a second-tier celebrity, who is now involved in a start-up, might show up. More elaborate affairs involve weekend trips to Richard Branson’s Necker Island or the Four Seasons in Punta Mita, Mexico, or even a pub crawl through Dublin with Bono. All of this exuberance is magnetizing the same diaspora of Wall Street bankers, models, college dropouts, and anyone else with a start-up idea who came to Silicon Valley in the mid-90s. “You know there’s a bubble,” the saying goes, “when the pretty people show up.”

The Domino’s Economy

Engineers and venture capitalists insist that things are different now. In the past, they’ve suggested, people were
just trying to get filthy rich. Now they are trying to “make the world a better place.” They are quite emphatic about it, too. Last year, Fortune reported that one of Airbnb’s executives said that he would love to see the company win the Nobel Peace Prize.

Indeed, there are many technologies that are genuinely changing the world—companies that aim to take people into space, or eradicate senseless traffic fatalities, or help people in developing countries by connecting them to the Internet. That shiny rectangle in your hand—the one that you are probably reading this story on—has unequivocally changed our lives in remarkable ways. Hashtags about racism, rape, police brutality, and inequality have offered a potent voice to those who were previously ignored. But the farcical line in the fictional Silicon Valley that people are “making the world a better place through minimal message-oriented transport layers” couldn’t be more true in the real one. All across the Valley, the majority of big start-ups are actually glorified distribution companies that are trying, in some sense, to copy what Domino’s Pizza mastered in the 1980s when it delivered a hot pie to your door in 30 minutes or less. Uber, Lyft, Sidecar, Luxe, Amazon Fresh, Google Express, TaskRabbit, Postmates, Instacart, SpoonRocket, Caviar, DoorDash, Munchery, Sprig, Washio, and Shyp, among others, are really just using algorithms to deliver things, or services, to places as quickly as possible. Or maybe it’s simpler than that. As one technologist overheard and posted on Twitter, “SF tech culture is focused on solving one problem: What is my mother no longer doing for me?”

This, perhaps, is the greatest similarity to what took place during the dot-com bubble, when a generation of companies were created to do more or less the same things. Webvan, the grocery-delivery business, raised $375 million at its I.P.O., in 1999—and reached a market value of as much as $7.9 billion— before eventually going bust. Kozmo, which initially offered free one-hour delivery, ended so abruptly that some employees arrived at work only to discover they had five minutes to retrieve their belongings and vacate the premises. And then there was the parabolic Pets.com, which sold kitty litter and dog food over the Web and raised $110 million from investors before descending from I.P.O. to out of business in fewer than 300 days.

Even if this generation of distribution companies is able to ride the shift from the desktop to mobile—64 percent of American adults now own smartphones—errand running has not proved an infallible business model. Kozmo and UrbanFetch lost so much money on orders and infrastructure that they ended up going kaput. Some more recent start-ups have subsidized their deliveries in a race to gain new users and grow their audience. Even Uber, which is now valued at around $51 billion, is reportedly operating at a loss of almost half a billion. As one prominent author who has written about Wall Street and Silicon Valley said to me, “How long can these companies continue to sell a dollar for 70 cents before you run out of dollars?”

For now, they may have a little while longer. The Federal Reserve’s decision to carry out multiple rounds of quantitative easing, in which the central bank stimulates the economy by buying securities, has flooded the system with cash. (“The whole world is awash with money,” says Christopher Thornberg, an economist who is best known for predicting the 2007 housing collapse.) Private-equity firms, not to mention China and Russia, now have the ability to help venture capitalists fund massive rounds of financing to prop up billion-dollar start-ups that have little in the way of revenue. Last year the Government of Singapore Investment Corporation led a $150 million round of funding for Square, the mobile-payments company. Tiger Global Management, a New York–based investment firm, took part in a $1.5 billion round for Airbnb. Collectively these start-ups have helped promote a culture of FOMO—or “fear of missing out,” in Valley parlance—in which few V.C.’s, who have their own investors to answer to, can afford to ignore the next big thing.

And this is where it gets particularly murky. These are private companies, with private balance sheets, and the valuations they ascribe to themselves aren’t vetted in the same way by the S.E.C. or public markets. These start-ups, in other words, can command much higher, and at times fabricated, valuations. One successful venture capitalist told me that he recently met with a unicorn that was seeking a new round of funding. When he asked the C.E.O. why he had valued his company at $1 billion, he was told, “We need to be worth a billion dollars to be able to recruit new engineers. So we decided that was our valuation.”

Another well-known venture capitalist told me a related story. When Instacart raised $220 million, this past winter, V.C.’s who had wanted to get in on the round were allowed to look at the company’s prospectus only inside a secure office. Investors were asked to refrain from using their cell phones at the meeting and banned from taking any pictures. The company claimed that these measures were taken to prevent anything from leaking to the press or competitors, but this venture capitalist said it felt suspiciously like the company was trying to control how much time investors could spend mulling over the company’s revenues and margins.

Indeed, contrary to Kupor’s argument at the Rosewood, it is this later-stage investing—with its shortage of regulation, tremendous envy, and Schadenfreude—that worries many bubble-watchers. “We basically doubled the number of unicorns in the past year and a half,” says Aileen Lee, the founder of Cowboy Ventures, who has herself become a mythic creature in the Valley after coining the term. “But a lot of these are paper unicorns, so their valuations may not be real for a while.” Others, Lee acknowledged, may never see their balance sheets add enough zeros to justify the title. They will be given a new sobriquet: “unicorpse.”

The problem with being a unicorn, indeed, is that there aren’t many exit strategies. Either you can go public, which is inadvisable without a lot of revenue, or you can sell, which is difficult given the paucity of companies that can afford to make such an offer. So, for many, the choice becomes fairly simple. You continue to raise more and more money, or you die.

Kaboom!

There is, however, one crucial difference between what’s going on now and what happened 15 years ago. On the eve of the dot-com crash, as 1999 rolled into 2000, few wanted the party to end. Tech I.P.O.’s had become a daily amusement, often doubling, and sometimes growing exponentially on their first day of trading. (One even popped up 978 percent before settling down at an unreasonable 606 percent before close.) As a result, gas-station attendants, college students, bankers, teachers, and retirees were all cashing in on these gargantuan returns. People who picked the right horse, which seemed like pretty much any horse, were able to sextuple their net worth in a single day—at least on paper.

Now countless people from all over want this to be a bubble and they want it to burst. There are the taxi drivers who have lost their jobs to Uber; hotel owners who have seen their rooms sit vacant as people sleep in Airbnbs; newspapers that are at the mercy of Facebook’s algorithms; booksellers and retailers who have been in an unrelenting war with Amazon; the elderly, who can’t keep up; the music industry; television producers; and, perhaps most of all, San Franciscans, who would rejoice in the streets if their rents fell from totally insane to merely overpriced, or if they could get into a decent restaurant on a Monday night. The bloggers who cover the technology industry would write a thousand jubilant think pieces saying “I told you so” to the venture capitalists who sneer and scoff when anyone comes close to mentioning the word “bubble.” As one prominent tech reporter told me, “Frankly, wiping that smug look off Marc Andreessen’s face—I can’t wait for that.”

Andreessen declined to speak to me for this piece, but his argument against the bubble is well documented. It is based, in part, on the fact that it hasn’t popped yet. (“Where’s the kaboom?” notes his Twitter bio. “There was supposed to be an earth-shattering kaboom!”) But timing these things isn’t easy. As the British economist John Maynard Keynes is said to have observed, the market can stay irrational longer than you can stay solvent. And calling these things early is a part of the process. Patrick Carlisle, chief market analyst at Paragon Real Estate Group, in San Francisco, has studied the great financial collapses over the past 30 years and said nothing ever happens when you think it will. “People started to talk about bubbles in 1998 and ’99, and said it can’t go on,” he said. “But it went on for another two years.”

The real difference may be that the biggest tech companies—Apple, Amazon, Facebook, and Google, among them—are indisputably now part of our social fabric. So perhaps this bursting won’t be as big and sudden and cataclysmic as the last one. Instead, things could simply slow down like a large tractor with a small hole in its tire. Maybe the “kaboom” will be a number of smaller, quieter pops—more like a correction—set off by something seemingly unrelated, whether it’s the collapse of Greece’s financial system, the fall of the Chinese stock market, or, God forbid, the election of Donald Trump. Meanwhile, according to CB Insights, start-ups have died at an average of one per week in 2015. Many wondered if we were getting the first intimation of the kaboom in August, when the Dow fell 1,000 points in the initial moments of trading hours.

But in whatever form this pop happens, some worry it could be worse than the last time. When the dot-com bubble burst, the Web was still in its infancy. Now, according to a McKinsey & Co. report, by 2011 Internet-related consumption and expenditure exceeded that of agriculture or energy. As Noah Smith, the noted financial writer, explained in July, the danger is not that we’re in a tech bubble but rather that we’re in an “everything bubble,” in which any one of these events could be the domino that makes it all fall down.

Ironically, whenever the kaboom happens, and in whatever form it takes, the people who are most protected will be the V.C.’s themselves. Most of them learned their lesson from the last bubble, and this time around have set up deals to ensure that if a company goes under, or has to sell itself for parts, any leftover money will go directly into their coffers—to “make them whole,” as the saying goes in the Valley, ensuring the investors get back what they put in. This doesn’t protect the hundreds of thousands of people who now rely on a paycheck from the errand-running start-ups or taxi disrupters. Nor does it help the mom-and-pop businesses that have bought into the hype of Zynga, Yelp, or Twitter, and invested their savings, which continue to plummet.

But don’t worry. This time is different.

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